With CPI Up, Fed Must Now Raise Interest Rates

The Consumer Price Index for March was just released. The monthly CPI number indicated that overall consumer prices rose by 0.4% in March, the same increase as the prior month. For the last year consumer prices have increased 3.5% up from 3.2% last month. With the increases since last December the proper monetary policy action is to raise interest rates now.

As I have noted in prior columns, the inflation problem has not been solved. Indeed, considering the rapid increase in oil prices over the last month or so, the CPI could hit more than 4% by June. In the recent past, the Fed has made two monetary policy errors which have resulted in high and lasting inflation. A third mistake will be devasting.

Inflation is a cancer that must be treated early and aggressively. The Fed failed to realize this in 2021 and failed again in 2023. Because of their failures, inflation remains a very sticky problem.

The core inflation rate is currently 3.8%, up from 3.7% last month. This core rate excludes price changes for food and energy. The core rate has remained in the 4% range for the last six months.

Inflation will accelerate in the coming months. Energy prices, which fell most of last year, have increased significantly. Oil prices have reached $90 per barrel, which has pushed the average price of gasoline to $3.60 per gallon nationwide. Much of the increase was incurred in the first week of April. That means the CPI number for April will be higher than the March number which will raise the annual CPI to near 4%.

Last year the Fed said they expected to cut interest rates as many as six times this year. Recently they revised that forecast and said they expect to cut interest rates only three times this year with all the cuts coming in the last half of 2024.

This latest data should cause the Fed to revise that forecast. Noting the increasing CPI, they will probably say that they will only cut interest rates once or twice this year. What they should say is that the time has come to raise interest rates. One or two rate increases before the end of the year will avoid the Fed making their third major policy blunder.

Recall the first Fed blunder was in all of 2021 and halfway through 2022. At that time the Fed held interest rates near zero and rapidly expanded the money supply mostly through their $120 million monthly bond buying program. They did this because they said the inflation was transitory. It wasn’t.

The second blunder was when they paused the interest rate hikes last September. As I wrote then, the pause will allow inflation to linger, which it has. They should have raised the Federal Funds rate two more times up to 6%. That would have ended the inflation problem without bringing on a recession.

Now the Fed must avoid a third monetary policy blunder. In the May meeting of the Open Market Committee, the Fed should announce that they will not cut interest rates at all this year. Rather they should raise the Federal Funds rate by at least 25 basis points. A 50 basis point increase would really work to stop inflation from escalating.

That probably won’t happen. In May and again in June, the Fed will acknowledge that inflation is rising but they will continue to believe that inflation will come down on its own. That means they will wait before they discuss any action on interest rates.

The problem is that the longer they wait to raise rates and bring inflation down, the more difficult these actions will be in the future. The federal government continues to run massive multi-trillion-dollar annual spending deficits. While that will help the GDP to grow, it is extremely inflationary.

The other major problem is wage inflation. Because inflation increased corporate profits, labor, last year, demanded large wage increases. Labor overall was successful with organized labor receiving as much as 6% annual wage increases. In some cases, these increases were in contracts that run up to four years.

We are in the very early stages of an increase in inflation. That’s the time when the Fed should act aggressively. Let’s hope they do that before the inflation problem becomes fully embedded in the economy.

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